Hurricane Joaquin Economic Impact Overblown

NEW YORK (TheStreet) -- Will Hurricane Joaquin will be an economic event for the U.S.? Despite potential destruction and loss of business days, the storm could actually be a neutral or additive factor to GDP in the fourth quarter. Let me explain.

A severe hurricane is headed for part of the U.S. and could interrupt millions of lives and force businesses to close. Should the storm hit, the key for the economy will be the magnitude of the damage and the length of the disruption. Some weather models have the storm heading toward the Northeast, which has a daily GDP of about $10 billion. Potentially amplifying the storm's national fallout are disruption to northeastern seaports, airports and rail lines, and potential damage to the region's energy infrastructure.

Natural disasters can be economic disasters. Hurricane Katrina's most important economic lesson is that officials must provide a rapid and appropriate policy response to a disaster to ensure that a disaster-stricken regional economy is simply detoured and not derailed. Unfortunately, this lesson came at the expense of New Orleans. Population in New Orleans remains below that seen prior to Katrina.

Whether Joaquin will be anything like Katrina -- as a storm or economically -- is still uncertain.

When natural disasters strike, the primary damage is done to productive capacity through the destruction of existing assets. This destruction is accounted for in the National Income and Product Accounts under the "Changes in Net Stock of Produced Assets" table (from the Bureau of Economic Analysis) but is not included directly in the GDP calculation.

Nonetheless, natural disasters affect GDP through a number of channels. Any clean-up and rebuilding will be captured in the regular source data on residential and nonresidential construction. The consumer spending component of GDP is also likely to be affected to the extent that federal aid and insurance payouts to households harmed by natural disasters supplement income rather than replace lost income.

Government aid boosts transfer payments, affecting GDP indirectly through consumer spending, while gross domestic income is increased directly through higher incomes. Consumer spending receives a boost as households replace lost or damaged items.

The destruction of those items is not recorded in the GDP estimate, but spending due to the replacement of those items is. Further, investment is not immune to natural disasters. Businesses will increase production to make up for the days lost during the storm and to replenish lost inventory.

The Cost

Ultimately the economic cost of Joaquin will depend on where and if it makes landfall in the U.S., the severity of damage to residential and nonresidential infrastructure, and the magnitude of power outages. Power outages cost the economy because affected businesses are closed after the storm. The effect can vary by industry as well. For example, lost output in industries where employees can work from home (assuming they have power) should be less than for manufacturing, retail and restaurants. Normally, restaurants are the big losers from natural disasters, as that lost spending isn't made up.

Odds are that Joaquin, should it strike, would be a net neutral to positive for fourth quarter U.S. GDP because rebuilding would add to GDP. This is widely debated among economists and the question nearly always surfaces after natural disasters. Those with opposing views often mention what is known as the broken window fallacy, which is based on the argument that destruction does not stimulate the economy.

A Lift to Economic Activity

The broken window fallacy does not hold today given the significant amount of spare capacity and cyclical unemployment in the potentially affected region. Therefore, federal funding, government spending, and some out-of-pocket expenses for homeowners would provide a lift to economic activity, because they would not have been deployed otherwise. For example, clean-up and rebuilding would put to work construction workers who would otherwise have remained unemployed.

There is also an important difference between economic activity and economic welfare. While those potentially affected by the storm would not be better off than if the storm didn't occur, over time economic welfare would improve. If done properly, any rebuilding needed could play an important role, as it would improve the capital stock. New infrastructure would replace old and outdated infrastructure. There could also be additional investment in preventive infrastructure.

Of course, the hope is that Joaquin ends up being neither a weather nor an economic issue for the U.S.